How much cyclical unemployment cab reduce inflation

Reference no: EM13184369

Suppose that an economy has the following Phillips curve:

t = t-1 - 0.6 (u - 0.04)

a. What is the natural rate of unemployment?

b. Graph the short-run and long-run relationship between inflation and unemployment. Clearly label the horizontal axis, the vertical axis, the slope of the short-run relationship and the intersection point between the two.

c. How much cyclical unemployment is it necessary to reduce inflation by 5 percentage points? Using Okun's law, compute the sacrifice ratio.

2. Suppose that the economy is initially at a long-run equilibrium. Then the Fed increases the money supply. Assuming any resulting inflation is unexpected, explain any changes in GDP, unemployment, and inflation that are caused by the monetary expansion. Explain your conclusions using three diagrams: one for the IS-LM model, one for the AD-AS model and one for the Phillips curve.

Reference no: EM13184369

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